Monday, 5 May 2008

On Junk Bonds, Mike Milken and the Current Crisis

Martin Lipton, an old time Wall Street operative and a founding member of Wachtell Lipton recently blamed Drexel Burnham and, by implication, Michael Milken and his junk bond enterprise, for the current credit/liquidity crisis. “The financial crisis we’re in today stems from the invention by Drexel Burnham Lambert of the junk bond,” he was quoted in the New York Times. “You can draw a straight line from Drexel Burnham to the financial world today.”

No single firm, especially a firm that collapsed almost two decades ago, can be the “source” of crisis of the magnitude we are witnessing. What Lipton is looking at, but cannot articulate because he does not comprehend, is the role of speculative capital.

What oiled the machinery of arbitrage was the U.S. Treasury market which the massive borrowing of the government in the 1980s institutionalized. The Treasuries provided a convenient and practical tool for simulating borrowing and lending. All one had to do was to go short or long. In a “reverse hedge,” the arbitrageur did not have to find a borrower because the largest borrower was always on the stand by, ready to provide the IOU on request. This catalytic function of the Treasury market transformed it into a critical component of the global capital markets. The debt itself became of secondary importance. In that regard, Ronald Reagan was as instrumental in the rise of speculative capital as the junk bond trader Michael Milken. Both were products of their time.